Counterparties: Not so golden, still delicious

By Ben Walsh
January 28, 2013

Welcome to the Counterparties email. The sign-up page is here, it’s just a matter of checking a box if you’re already registered on the Reuters website. Send suggestions, story tips and complaints to Counterparties.Reuters@gmail.com.

Apple’s stock is down 23% in the last six months. Last week’s earnings report caused an overnight drop in shares from $514 to $461. Earnings growth is decreasing. Investor Jeff Gundlach thinks it’s a “broken company” where innovation has been reduced to “just changing the size of… products”. Fast Company explains “Why Apple is losing its aura” while the WSJ asks “Has Apple Lost its cool to Samsung?”

Not so fast. Legendary VC Michael Moritz, who first bought Apple equity in 1978, has stepped into the doomsaying to decry the lack of “any sense of perspective”. Quarterly revenues, he notes, grew 18%, and topped $50 billion for the first time. And while Apple does face stiff competition, it’s only because it is so successful:

Almost every company in the world suffers from acute Apple envy. Apple has thrown several mainline industries, including music, movies, television, publishing, cameras and 35mm film, into convulsions… It is difficult to think of a company of the past 50 years whose influence and ingenuity have been as profound or widespread.

John Abell voices the nagging concern that Apple just doesn’t tell shareholders enough about what it’s up to. That’s really nothing new: Steve Jobs was notoriously hostile to shareholders, and seemed to relish ignoring them. Tim Cook hasn’t changed tack.

It’s not just more information some Apple shareholders want — they’d like management to be fixated on the stock price. In practice, that seems to mean a monomaniacal preference for buybacks as far as they eye can see, rather than investments in product development or the company’s supply chain. But Apple’s view on this issue won’t change: Jobs ignored Warren Buffet’s advice to use cash to buy back stock.

The difference between a CEO obsessed with products and an investor obsessed with finance, is the difference between Apple and Berkshire Hathaway. In turn, that might help explain why, as Farhad Manjoo writes, “the market attitude toward Apple seems unmoored from its actual performance”. — Ben Walsh

On to today’s links:

Ugh
The personal finance industry thinks women have a problem (and it’s not unequal pay) – Slate

Crisis Retro
What the Fed really missed: the declining financial health of consumers – Mike Konczal

Baby Steps
America’s ridiculous immigration system may be nearing semi-reform – NYT

Legalese
How online retail was saved by shutting down the “shopping cart” patent – Ars Technica

Remuneration
SAC is in so much trouble it’s paying its employees more – Peter Lattman

Confessions
IAmA Glencore Trader AMA – Reddit

Departures
Time Inc said to be laying off 700 people – All Things D

Leaders
“The beard does not judge the one-percent” – A Continuous Lean

Oxpeckers
The gushing MSM headlines about the stock market are back – Sober Look

10 comments

We welcome comments that advance the story through relevant opinion, anecdotes, links and data. If you see a comment that you believe is irrelevant or inappropriate, you can flag it to our editors by using the report abuse links. Views expressed in the comments do not represent those of Reuters. For more information on our comment policy, see http://blogs.reuters.com/fulldisclosure/2010/09/27/toward-a-more-thoughtful-conversation-on-stories/

Apple’s revenues actually grew more than 18%; the last quarter was a week shorter than the same one in 2011, and given that it was in the busiest (holiday) quarter, revenue could have easily been 8% higher, which means it really grew more than 25%.

Calling them a broken company is absurd, for even though the customer upgrade cycle has slowed to where it is probably more than the length of a 2 year contract, they are still attracting new customers. They are priced like a bank or utility, even though their profits and growth are like a software growth company.

Ben is right, lots of shareholders want Apple to focus on share price, but they’ve never done that since Jobs returned, and I don’t think (or hope) Cook will care, either. Apple also doesn’t care about market share to the point where they will lower prices and margins just to get a bigger share; they’re just not that short-sighted.

As an Apple shareholder, I do hope they don’t buy back shares. I would rather they increase their dividend, which would be more likely to put some of their cash hoard back into circulation than a buyback. It would also have a more immediate impact on the share price.

Posted by KenG_CA | Report as abusive

Aapl vs. Amzn is all that needs to be said about the ridiculousness of the stock market.

For the record, I am deeply ensconced in the Amzn eco-system and am less than thrilled with my iPhone. Still, how can a company making that much money go down in value. It’s ridiculous.

Posted by Zdneal | Report as abusive

I pretty much agree with KenG’s points (and am also an Apple shareholder). I differ a bit in that I wouldn’t mind if the company buys back shares, though I don’t have any huge preference for that move relative to a big special dividend. Just the latter or a mix of the two would be fine with me.

I don’t think that Apple management should spend an inordinate amount of time fretting about where the stock trades day-to-day. They should, however, think about judicious use of capital. Apple’s cash and equivalents at 12/31/12 totals $137.1 billion (I’m adding together Apple’s reported cash, short-term marketable securities, and long-term marketable securities). Apple earns minimal returns on this money: assuming that Apple’s $462 million in other income/expense for the latest quarter is all interest, Apple is earning something like 1.3% on an annual basis. That number involves a bit of an estimate, but in the current interest rate environment it seems reasonable assuming that Apple is investing in government bonds and high-rated corporate bonds with maturities of a few years or less. Even if one adjusts this return relative to what would end up with shareholders post-tax through dividends or stock buybacks, the return on this cash hoard is pretty anemic. (Assume incremental corporate taxes for Apple to bring the money on-shore, and a 20% individual dividend/cap gains rate, and Apple’s return on that cash is still no more 2% to 3%). Seems to me that Apple could send $100 billion of this cash to shareholders and still have more than enough spare cash for any reasonably likely corporate initiatives, so the Apple board and management are deciding to accept a sub-3% return on a huge pile of invested capital. I like Apple’s business, especially at the current share price, but I’d like to be able to buy stock in that business without also purchasing the short-term bond fund that’s presently attached to the business.

Posted by realist50 | Report as abusive

What is Apple doing with $90 billion in cash? They’re not paying it out in dividends and they’re not buying back stock. They’re not putting it to any productive use, which is why the cash is just sitting there. And while it’s just sitting there, it’s earning a whole lot less than stockholders can earn if management would give the money back (to its rightful owners). I understand keeping a reserve for unforeseen circumstances, but $90 billion is over the top.

As long as the company was pumping out new products investors didn’t mind so much. Now, though, things are different. The company certainly isn’t broke, that’s for sure, but it’s telling that management has no use its cash, but is being a dog in the manger to keep it away from stockholders.

Posted by WilliamCowie | Report as abusive

I hadn’t been an Apple shareholder in quite a while, but couldn’t resist $440. The company would need to completely fall apart to make THAT a bad purchase.

They’ve got the free cash flow to support a $20/share dividend, which could help to support an $800 price. Failure to pay out that hoarded cash could easily be interpreted as uncertainty about how long these boom times will last.

At some point you have to wonder what that cash is good for?

Posted by TFF | Report as abusive

Amazing how few analysts really understand why Apple is successful. Without understanding the company at all (just overlaying a standardised model that has not made any other tech company half as successful as Apple) recent quotes from analysts include (just before the price dropped) “Apple could go over $1,000 a share” and “Apple needs to launch a cheaper phone to fight for market share”.

Then you read about problems for all other phone makers due to insufficient profits, which come from selling too many models at too low prices in the fight for market share. Have the analysts forgotten that “sales are vanity; profits are sanity”? Have they also forgotten that it wasn’t so long ago that Apple was nearly bankrupt and had to be rescued by Microsoft money? Or that that near-bankruptcy was caused by the actions of John Sculley, the market darling who ousted Steve Jobs so he could do what the analysts said the company needed to do?

As for calculating the net return on the cash pile, well, that’s just barmy. Investors are investing into the Apple model, not a cherry picked part of it. Having a high cash pile allows Apple to place huge forward orders on parts; to buy any company it wants, when it wants or needs to; to invest in the machinery in the factories that build its equipment – Apple might not own the factories, or run them, but they do own a lot of the machines inside them.

Apple doesn’t just screw computer parts together – it invents the machines and processes needed to make better computers more cheaply. Having cash around allows the company to be more adventurous in research, knowing it can launch a product out of the mould that might flop, or might be a star – and all without risking the company.

When analysts stop talking rubbish, I might take them more seriously.

Posted by FifthDecade | Report as abusive

So Fifth, you are telling me that they need $150B of cash for capital expenses and forward orders? I’m not buying it… That’s an argument for a $30B cushion, not a $150B cushion.

Your third suggestion, “to buy any company it wants” is more intriguing. Especially since it HASN’T been using (wasting?) its cash that way. What do you think Apple might be saving up its pennies to buy? What SHOULD they be aiming to buy?

Will repeat myself: at some point you have to wonder what that cash is good for? Arguments that supported $30B of cash in 2009 don’t make much sense in the face of a $150B hoard.

Posted by TFF17 | Report as abusive

TFF17, I’m sometimes not sure the cash pile is actually big enough for what Apple would really like to do.

What do I think they would like to do with it? I think they would like to get out from under the thumb of the carriers, or otherwise commoditize them. Imagine what would happen if Apple sold data plans for their devices at only a slight profit, like they do with their online stores (which still pull in 2B). I’m talking about < $50 a month for unlimited everything– they would kill it. This would be not only for mobile, but for devices at home, like the mythical TV.

For this to happen they'd have to save up enough to buy/start a semi-serious telco in all their major markets: US, UK, France, Germany, Italy, China? (probably not).
I'm thinking >200B is where this might start being feasible.

Posted by craigyk | Report as abusive

TFF – you are correct that Apple’s cash is well in excess of any corporate use for it other than an acquisition. None of Fifth Decade’s arguments about Apple’s need for that much cash hold water when examined versus Apple’s actual financial results.

Huge forward orders of parts? Maybe Apple does so on occasion, but in total it consistently operates with negative working capital – looking at non-cash current assets less accounts payable – meaning that on the whole Apple’s suppliers finance it, not vice versa. Not surprising since Apple turns inventory very quickly and obviously has plenty of power to negotiate favorable terms with suppliers, including payment terms. It’s a testament to Apple doing a good job running its supply chain.

As for cap ex, that was $2.4 billion in the most recent quarter, and $8.3 billion in the latest fiscal year. That’s compared to cash flow from operations of $23.4 billion in the latest quarter and $50.9 billion in the latest fiscal year. Apple’s cash flow from operations could fund somewhere between a 6x and 10x increase its cap ex. Bear in mind that this massive increase in cap ex wouldn’t even put a dent in Apple’s cash pile – it would just stop its cash pile from growing. Apple’s dividend of $2.5 billion per quarter barely alters this equation.

As for R&D, that’s an expense item that is already take into account in calculating net income or cash flow from operations.

Having that much cash, and generating still more, is a high-class problem to have, but still doesn’t mean that Apple should just sit on the cash. As profitable as the company is, I’m taking it as a given that Apple is pursuing any R&D or cap ex spending that it thinks would earn a reasonable return.

As for acquisitions, I don’t see any logical ones that would use tens of billions of cash. Apple’s history has been relatively small acquisitions with specific interesting technology and a limited number of employees. It’s tough for me to see Apple buying a company with thousands, or tens of thousands, of employees. Integration of a business of that size would be a new experience for Apple and a distraction for management.

Let’s say Apple decided to return $120 billion of its cash – still leaving it with $17 billion on its balance sheet. Conservatively assume a 20% incremental tax rate to repatriate the cash, leaving $96 billion to distibute. 939 million shares outstanding, so that’s either a $100 per share special dividend or a massive share buyback – such a large share buyback that it’s likely not feasible without moving the stock.

Posted by realist50 | Report as abusive

My few cents on AAPL:

#1 no way no how do they ever repatriate that foreign cash for anything like a 20% rate. Why on earth would they pay 20 billion in taxes to uncle Sam on iphones built and sold outside of America? Unless the laws change the foreign cash will stay where it lays.

#2 one off the wall idea I could see Apple wasting/investing some big money on would be to lock up their own spectrum. If I was running AAPL I would have bought Clearwire when it was at $2 and then used the spectrum exclusively to deliver paid iTunes content.

Posted by y2kurtus | Report as abusive